Supply Chain Management

Solutions to questions from the class + Bonus question

Hotel California
• Hotel California is a luxury hotel which has just got a new manager, Rocky.

• Given its location and quality, the hotel always had enough people making advance reservations to fill up all the rooms available.

• The hotel charges $200 per room per night for reservations made in advance.

• Rocky had heard about techniques to improve revenues in a seminar he had attended and decided to implement them in his current job.

• He implemented a policy of keeping some rooms free for last minute requests and charges these last-minute requests $300 a night. Currently, the
hotel keeps 3 rooms free to accommodate last minute requests.

• After implementing the policy for a few months, the management reviewed their records and found the following.

Number of rooms 0 1 2 3 4 5 6 7
requested at the last
minute
Frequency (# of days) 25 15 30 40 20 5 5 10

• Is keeping 3 rooms free for last minute requests optimal?

2
Hotel California
Number of rooms kept 0 1 2 3 4 5 6 7
free (Q)
Frequency 25 15 30 40 20 5 5 10
(# of days last minute
requests = Q)
Probability (D = Q) 0.167 0.100 0.200 0.267 0.133 0.033 0.033 0.067
Probability (D <= Q) 0.167 0.267 0.467 0.733 0.867 0.900 0.933 1.000

• Additional revenue from a last minute request

– Cu = $300 - $200 = $100

• “Loss” from unused room

– Co = $200

• Optimal service level

– Cu/(Cu + Co) = 1/3 = 0.333

• Optimal number of rooms = 2 (smallest Q where Prob (D<=Q) >= Optimal service level

3
Managing inventory of wheat flour (revisited)
• Recall the bakery’s raw material procurement process

– The bakery estimates a weekly demand of 100 lb. for the wheat flour on average. However, the weekly demand is not certain and
has a normal distribution with mean 100 lb. and standard deviation of 20 lb.

– The supplier has gotten busier and lead time for delivery is now 2 weeks.

– The bakery would like to maintain a 99% service level, i.e., probability that products cannot be made because of unavailability of
flour should be no more than 1%.

– When should they now place orders with the supplier? That is, how should they adjust their reorder point?

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Uncertain demand and ROP for wheat flour - Answer
• For the bakery,
– R = 100 lb / week
– 𝜎 = 20 lb
– L = 2 weeks
– SL = 99%

• 𝑅𝑂𝑃 = 𝑅 × 𝐿 + 𝑍𝑆𝐿 × 𝜎 × 𝐿 = 100 × 2 + 2.32 × 20 × 2 = 200 + 65.8 ≈ 266 𝑙𝑏

• Safety stock 𝐼𝑆 = 𝑅𝑂𝑃 − 𝑅 × 𝐿 = 65.8 ≈ 66 𝑙𝑏

5
Example: Fun Colors
• Fun Colors Inc keeps one-gallon cans of 75 different colors in the store with sufficient inventory that they would be able
to meet demand 98% of the time. Demand for each color is more or less the same, independent of demand for the other
colors, and follows a normal distribution with a mean of 100 cans per week and standard deviation of 40.

• The store ordered each color from a factory located far away and the delivery time was around 2 weeks. Fun Colors paid
$3.5 per can
– How much safety stock of each color was required to support Fun Colors’ planned availability? What is the reorder point (ROP) for
each color?

• Suppose they now have equipment to mix any color from one base-tone paint. Lead time for base-tone paint remains 2
weeks.
– What is the safety stock required for the base-tone paint? Compare this with the total safety stock (across all colors) required
before.

6
Fun Colors – Solution (I)
z value for 98% level = 2.05
Standard Deviation (S.D.) for weekly demand = 40

a)How much safety stock of each color was required to support Fun Colors’ planned availability?
S.D. over lead-time of 2 weeks = 2 * ( S .D.)2 = 56.56

Safety Stock = z value * Lead time S.D.

= 2.05 * 56.56
= 116 cans

ROP = Lead time demand + Safety Stock

= 2*100+116 = 316 cans

Safety Stock across 75 colors = 75*116 = 8700 cans

Fun Colors – Solution (II)
z value for 98% level = 2.05
Standard Deviation (S.D.) for weekly demand = 40
b) Suppose they now have equipment to mix any color from one base-tone paint. Lead time for base-tone paint remains 2
weeks. What is the new safety stock?

S.D. for 1 week for base (pooled) = 75 * ( S .D.)2 = 347

S.D. across lead-time for base = 2 * ( S .D.)2 = 491

Safety Stock = z value* S.D. across colors across lead-time

= 2.05*491 = 1007 cans < 8700 from part a)
Northern Airlines (Bonus problem)
Northern Airline wishes to train new flight attendants in an economically rational way. They require a staff of about 1,000
trained attendants to maintain their flight service. Due to the nature of the job, there is a high turnover rate, with the
average job tenure being two years. This creates an annual demand for about 500 new flight attendants.

The training course takes six weeks, after which the trained attendants take one week of vacation and travel time before they
enter the pool from which they are assigned to flight duty as needed.

During training and the one week of vacation the flight attendants are paid a weekly salary of $75. Once they join the pool
they receive the regular weekly salary of $125. The training costs consist primarily of the salaries paid to the instructors
($220 per person per week) and to the support personnel ($80 per person per week). A training team consists of 10
instructors and 10 support personnel. The training team is only paid for the time engaged in training and their pay is
irrespective of the size of the class they train.

What is the optimal training batch size?

Solution to additional exercise